Working paper argues new US energy efficiency regulations are ineffective at GHG reduction and incorrectly override consumer preference

14 July 2012

Recent US energy regulations proposed or enacted by the US Department of Energy (DOE), the US Department of Transportation (DOT, and the US Environmental Protection Agency (EPA) have a negligible effect on reducing greenhouse gases. Instead, according to a new working paper by a duo from The Brookings Institution and Vanderbilt University, the bulk of the estimated benefits from the regulations stem from private benefits such as fuel savings to consumers, based on the regulators’ presumption of consumer irrationality.

“Rather than squander societal resources on more ineffective policy efforts, a more productive approach would be to search for policy options that offer greater potential for making a serious dent in greenhouse-gas emissions,” the authors conclude in their paper.

Ted Gayer, co-director of the Economic Studies program and the Joseph A. Pechman
Senior Fellow at the Brookings Institution, and W. Kip Viscusi, Vanderbilt University Distinguished Professor, with primary
appointments in the Department of Economics and the Owen Graduate School of Management as well as in the Law School, set out to examine the economic justification for recent US energy regulations. The case studies include the proposed CAFE fuel economy requirements and US Environmental Protection Agency (EPA) greenhouse gas regulations for motor vehicles; and energy-efficiency standards for clothes dryers, room air conditioners, and light bulbs.

The efficiency rationale for any government regulation rests on the existence of some type of market failure. The ways markets may fail are quite diverse, ranging from characteristics of the market structure to various kinds of externalities; that is, adverse effects on parties other than the buyer and seller of a product. In the absence of some type of market failure there is no legitimate basis for regulation from the standpoint of enhancing economic efficiency.

This article examines a major class of recent government initiatives by the US Department of Energy (DOE), the US Environmental Protection Agency (EPA), and the US Department of Transportation (DOT) pertaining to energy efficiency (as distinct from economic efficiency). The regulations of interest all pertain to consumer products that are durable goods. There may be some kind of market failure with respect to the energy usage of these products, as energy use leads to environmental consequences. However, the existence of an imperfection alone cannot justify all regulations that take the form of government intrusion into the marketplace to override consumer choices.

We examine the justification for these energy regulations and show that demonstrable market failures are largely incidental to an assessment of the merits of these regulations. Rather, the preponderance of the assessed benefits is derived from an assumption of irrational consumer choice. The impetus for the new wave of energy-efficiency regulations has little to do with externalities. Instead, the regulations are based on an assumption that government choices better reflect the preferences of consumers and firms than the choices consumers and firms would make themselves. In the absence of these claimed private benefits of the regulation, the costs to society dwarf the estimated benefits.

—Gayer and Viscusi

Gayer and Viscusi start by advocating the mainstream approach of evaluating the merits of regulations based on their benefits and costs and whether, on balance, the regulations promote social welfare—an approach they say is consistent with the approach federal regulatory agencies followed since President Bill Clinton issued an Executive Order to that effect in 1993.

That approach, however, merely frames the issue, leaving open the determination of what is a cost or a benefit. Gayer and Viscusi suggest that government agencies are not properly assessing the beenfits from energy-efficiency standards.

The assumption that the world outside the agency is irrational is a direct consequence of the agencies’ view that energy efficiency is always the paramount product attribute and that choices made on any other basis must be fundamentally flawed.

The most prominent economic justification for environmental policies is to remedy a market failure due to externalities, which do represent actual potential benefits of energy-efficiency standards. The classic example of an externality is the release of air pollution as a byproduct of production of a marketable good. The air pollution harms human health, but abatement raises the firm’s production cost. If the government clearly establishes a property right for the clean air, then depending on who owns the property right, either polluters would need to purchase the use of the air or the victims of pollution would need to pay polluters to reduce pollution.

Either way, as Ronald Coase demonstrated, the social costs of air pollution are internalized into the market decision, resulting in an economically efficient outcome. However, high transaction costs frequently prevent the affected parties from reaching an efficient solution, especially in the case of air pollution in which large populations are exposed to pollution. As a result, abatement is not undertaken since the production decision is made without considering the external harm to human health. In these cases, more direct government intervention (whether through market-based instruments such as a pollution tax or through command-and-control regulations) can achieve the level of air-pollution reduction that increases net benefits to society.

Environmental policies can be most successful at maximizing net benefits—or at least improving net benefits relative to the nonintervention case—if they are designed after careful consideration of unbiased estimates of the costs and benefits of environmental quality. Benefit-cost analysis (BCA) provides the methodology for such an assessment and is the key component of effective regulatory policy.

—Gayer and Viscusi

Gayer and Viscusi argue that the analyses for the recent energy regulations make an increasingly important methodological challenge to BCA concerning the treatment of private benefits to individuals from government regulations.

In a post on the Brookings website, Gayer notes that cost-benefit analyses traditionally assume that informed citizens are best able to understand and choose among the available options for the one that best meets their own interests. A regulation that requires consumers to buy a more expensive, more energy-efficient product, for example, may produce social benefits from reduced pollution, will not otherwise make the consumer herself better off.

While some studies are questioning the assumption of consumer rationality underlying BCA, Gayer and Viscusi write, the existence of some systematic behavioral anomalies that do not accord with fully rational behavior does not imply that those anomalies are ubiquitous and consequential in all economic situations.

Just as one would want to assess whether a pollution externality is trivial or important, it is also essential to document both the existence and magnitude of behavioral anomalies if they are to be used as a justification for government intervention.

...If BCA abandoned the presumption of consumer sovereignty and replaced it with another assumption about the systematic behavior of consumers, it would lead to the normative implication that the analyst or policymaker decides what is best for each consumer. Given the informational and analytical challenges of finding behavioral failings among heterogeneous individuals, this is a tall order for any analyst or policymaker, especially given that they are also prone to information and behavioral failings.

...A shift away from the principle of consumer sovereignty will also lead to regulations focused more on correcting self harm than on internalizing environmental harm. For example, it would place greater weight on regulations that ban energy-inefficient products than on regulations that raise the price of pollution. Policies designed to focus on addressing the purported irrationality of the consumer rather than on the traditional goal of internalizing external costs of pollution will sacrifice some pollution reduction for more protection of the consumer from self harm. Therefore, the burden of proof for any BCA conducted as part of a review of regulatory proposals should be placed heavily on justifying any presumption of a deviation from consumer sovereignty. The agency preparing the BCA needs to demonstrate a systematic deviation from consumer rationality rather than just presuming that the regulator is better equipped to make decisions that protect individuals from themselves.

—Gayer and Viscusi

NHTSA CAFE and EPA greenhouse gas standards for vehicles. For the analysis of impact of the proposed joint national program of CAFE and greenhouse gas standards for passenger cars and light trucks (for 2017 and later model years), Gayer and Viscusi note, EPA and NHTSA needed to derive input values for such things as vehicle miles driven per year, the responsiveness of annual vehicle miles driven to changes in fuel cost, the magnitude of the rebound effect (which is the increase in driving that would occur with more fuel-efficient vehicles), projections of future fuel costs, the number of years the vehicle would be in service, the relationship between the measured fuel efficiency and the actual on-road efficiency, and the discount rate.

The analysis, the authors argue, presumes the regulator is better than the consumer at computing the various inputs to the net present value (the value today of a stream of future benefits, less costs) computation and the consideration of different vehicle classes controls for other features of the vehicles that might appeal to the consumer. This assumption, they note, effectively rules out consideration of motor-vehicle attributes other than fuel efficiency that will be affected by the regulation.

The dimensions of consequence in the EPA and NHTSA analyses essentially convert all motor vehicles into three-attribute products. Cars serve as a means of transportation whose only other dimensions of interest are mpg and cost. One does not have to be a reader of automobile reviews in Edmunds.com, Car and Driver, or Road and Track to realize that fuel efficiency is but one of many factors people use to assess the quality of an automobile. Acceleration, handling, braking ability, legroom, riding comfort, safety, reliability, styling, and trunk storage are among the many other dimensions of concern to automobile purchasers. Indeed, most automobile reviews note the tested vehicle price and the mpg but then focus on other vehicle characteristics of consequence to consumers but not as readily apparent. Econometric studies of the determinants of automobile prices likewise recognize the importance of product attributes in addition to fuel efficiency.

...The analyses by EPA and NHTSA ignore the loss in consumer welfare that would result if achieving higher fuel-economy standards means manufacturers have to sacrifice any of these other vehicle characteristics. The EPA and NHTSA analyses abstract from all these concerns and focus on several cost-related aspects. In addition to the calculation of lifetime fuel savings to the consumer, the regulators also compute the private consumer surplus from additional driving (that is, the private benefit to consumers net of driving costs that occurs because the amount of driving increases as fuel efficiency increases) and the private benefit of reduced fueling time (because consumers would have to refuel less often). The sum of these private net benefits to the consumer represents the bulk of the benefits of the fuel-efficiency mandate for both the NHTSA and EPA analyses.

—Gayer and Viscusi

Specifically, NHTSA estimates a total cost of $177 billion and a total benefit of $521 billion. Of the $521 billion in benefits, $440 billion (85%) stem from private savings to consumers, including $416 billion in lifetime fuel savings, $9 billion in consumer surplus from additional driving, and $15 billion in refueling time value.

EPA estimates for its regulations are similar: $192 billion in total costs and $613 billion in total benefits, 87% of which are private benefits to consumers: $444 billion in lifetime fuel savings, $71 billion in consumer surplus from additional driving, and $20 billion in refueling time value.

The environmental benefits play a largely incidental role in both analyses. In the NHTSA analysis, the estimated benefits from reducing the greenhouse-gas carbon dioxide accounts for only $46 billion, or 9 percent of total benefits. The greenhouse-gas carbon dioxide benefits in the EPA analysis are also $46 billion, or 8 percent of the benefits EPA estimates.

Even these comparatively modest benefits overstate the benefits to the US citizenry, since they also include the climate-change related benefits to other countries of reduced emissions within the United States. To the best of our knowledge, this is the first situation in which benefits to countries other than the United States have been included in a regulatory impact analysis.

If one counted only the domestic benefits, the social cost of carbon dioxide benefits would be just 7 to 23 percent of the estimated carbon dioxide benefits. Counting only domestic benefits would reduce the CAFE rule’s greenhouse benefits from $46.4 billion to a range of $3.2 billion to $10.7 billion. The domestic benefits of reducing greenhouse gas emissions therefore only account for 0.6 to 2.1 percent of total estimated benefits. The estimated costs of the regulation are 18 to 60 times greater than the domestic greenhouse-gas benefits. If the purpose of the standards is to reduce greenhouse-gas emissions, these regulations are very inefficient.

—Gayer and Viscusi

Moving forward. In their conclusion, Gayer and Viscusi pose the question as to how consumers could be as remiss as suggested by the regulations, in effect “leaving billions of potential economic gains on the table by not buying the most energy-efficient cars, clothes dryers, air conditioners, and light bulbs?”

It should be a red flag that something is amiss with an analysis that assumes such perplexing consumer and firm behavior that runs counter to the most rudimentary economic theory and our general sense that we do not live in a world in which people never make sound choices. It might be that there is something that is incorrect or perhaps even irrational in the assumptions being made in the regulatory impact analyses. Indeed, upon closer inspection it is apparent that there is no empirical evidence provided for the types of consumer failures alleged. Even if some consumers do sometimes fall short on certain dimensions of choice, the magnitude and prevalence of such a shortfall is important and is never addressed in the regulatory assessments. Nor is there adequate consideration of the actual and potential role of informational remedies that have already been adopted.

—Gayer and Viscusi

Gayer and Viscusi suggest directly that “Perhaps the main failure of rationality is that of the regulators themselves.” Agency officials given a specific mission tend to focus on those concerns, and assume others are either irrelevant or will be included at no additional cost in the post-regulation products, the authors posit. They suggest several possible courses of action:

Noting that even though the legislation mandating these standards may not permit the Office of Management and Budget (OMB) to provide credible evidence of the market failures pivotal to justifying the regulations, the authors suggest that there could be changes to the analysis to show the true economic burdens of the regulations.

OMB should also require agencies to prepare analyses in which the domestic greenhouse-gas benefits are included as benefits instead of the greenhouse-gas benefits to the world.

Regulatory analyses for energy-efficiency regulations should have much firmer economic grounding than the current engineering approach.

Comments

Brookings is a propaganda arm of the Republican party. Designed to give the impression of academic integrity without having it. Shame on ANY university for whoring themselves out to lend credibility to Brookings.

Studies like this lack vision, and fail to take into account two words..."Disruptive Technology".

With efficiencies approaching thousands of percent better than all current chemical combustion, new plasma-based technologies will soon make the burning of fuels simply appear silly...and very, very expensive.

For examples of this plasma tech revolution, see Keshe Foundation, http://www.keshefoundation.org/en/applications/transportation

I wonder why not mentioning tailpipe polution impact against power generation stack polution impact on human health cost? This should be important factor when considerng vehicle electrification strategy, possible taxation and subsidies. Another issue - energy security risk managment cost. No mentioning when discussing efficiency and fuel BCA. Third issue - no discusions on power generation air polution reduction at all.

Quite to the contrary of the Brooking institution, the US has recently reduced petroleum and coal consumption significantly. The end result is that CO2 emission has come down and that the regulations are working as intended. With upcoming EPA regulation to limit CO2 release of power plants to under 1000 lbs per MWh, we will see more phasing out of coal plants.

With upcoming EPA regulation to limit CO2 release of power plants to under 1000 lbs per MWh

But instead of aiming also at plants emitting less, the plant emitting 999 lb/MWh gets the same treatment as the plant emitting 0. This is part of the favoritism of regulations which advances (in this case) gas-fired generation over nuclear.

"the preponderance of the assessed benefits is derived from an assumption of irrational consumer choice."

The authors suffer from a heretical premise: the existance of a rational consumer.

Consumers are seldom rational. Why else would they refinance their home duing a bubble, or purchase an SUV in the midst of rising commodity prices?

Of course government is made of consumers as well. It grants the irrational consumer $4000.00, not to crush the clunker, but rather to replace it with a slightly more efficient one, while spending another $20K+.

Humans by nature seek the path of least resistance. Making the rational choice for efficiency requires the processing of lots of information, that often is not readily available. Automakers and Wall St. know this, and use it to their advantage. For an automaker, using technology long since amortized always makes more economic sense. Advertise the VOLT, sell the Suburban.

The Brookings institute study is based on the philosophy that there is something inherently wrong with George Orwell’s world of 1984.

This is just more scare tactics, like the use of such “scare terms” as totalitarian ideology, mind control, thought crimes, privileged Inner Party elite, brainwashing children, Big Brother, persecution of individualism, eminent domain, etc.

They try to force the government to justify legislation that we all KNOW is the right thing.

The scientific method is just a materialistic tool to prevent the state from accomplishing what is obviously for the greater good.

Yes the right place to start IS in kindergarten. The Village, not the Family, should raise our children.

What the Brookings institute fails to realize is that the benevolent State need not force us to buy fiscally unsound BEVs; it just makes us pay for other people’s BEVs.

And we all KNOW in our hearts this will magically reduce BEV cost so they become economical. We just know it; just like we know that any study that criticizes the State is evil, probably emotionally laden, even racist.

The State does not need to jail the mentally defective for eating hamburgers, just make hamburger sales illegal.

There is no justification for individuals to own property, PEOPLE should own property, and that means THE people, the State.

The superiority of the authoritarian state was not obvious in Hitler’s Germany, Russia or Cuba - but China shows we simply needed unquestioning support of the people to show its superiority.

The authoritarian state IS “for” the people; but keeping in mind these same people CANNOT be trusted to buy the most economical auto or light bulb.

China is the new utopian, authoritarian state – go east children; go and leave be whatever freedom and incentive based culture is left in the US; go now lest you miss the benefits of the great proletarian cultural revolution; just go.

Let's look at some consumer choices with the idea that there are diminishing returns when it comes to energy efficiency:

At a big box store, I can buy a 10,000 BTU, SEER 10 energy star window air conditioner for $279.

I can buy a ductless heat pump rated at 9,5000 BTU, SEER 13 for $829 not including the more difficult installation.

The big box store does not have a SEER 26 so I looked at Ebay..

SEER 26+ Heat Pumps
US $1,579.00 \
9000 BTU

SEER 13+ Heat Pumps
US $962.00
18000 BTU

So you can get about twice cooling equipment for half the cost.

Six years ago I replaced our old system with a SEER system. Here is a link that shows the diminishing returns and will help calculate the operating cost: http://www.alpinehomeair.com/learningcenter/lc.cfm?categoryID=92&shopto=134&videoID=DBC2ACFE-28F9-4185-97D2-EEEC7096D2AA&playonload=1

So while upgrading the system will save $50 per month going from SEER 14 to 16 will save $5.25per month but going SEER 16 to 1 will save $2.41

The payback period for the SEER 16 increment is 12 years and SEER 18 increment is 17 years.

The conclusion I come to is that I do not want the average poster here or the government making choices for me. What should save liberals in that I have the knowledge and skill to make choices for you. So if you want that I kind of world then I will be happy to the energy police.

Off you go to a government reeducation camp where you will live in barracks with one CFL. Careful what you ask for.

Kit P...made in China SEER 26 and 27, 12000 to 18000 BTU Split Inverter type, very quiet Heat Pumps are now available for under $900, including shipment cost to your door. I've seen two young technicians install three to four units in the same day for $300 to $400 each.

Those are the very best Japanese designed units guaranteed for 7 to 10 years.

Pay back time versus your old SEER 10/12 AC and oil/NG furnace is often less than 2 years. After that short period you will gain financially and in comfort level. Many, but not all, will also feel better because they will consume less imported fossil fuel and will contribute to the national economy recovery.

@Lasvegas
I did the calculations. Since part of my day job is doing calculations for nuke plant, I am confident that I did them correctly. I used the website to get consistent data for comparison. The numbers also track very close for the system I that I have.

If you look at HarveyDs 'often less than 2 years' you have to realize he is not doing a correct analysis. You do not compare an old broken system to a new one or to different type of equipment. You compare a 4 ton SEER 16 to a 4 ton SEER 18 if the same design.

Second I do not think it is possible to have a 2 years pay back period. Maybe if you live someplace that is very hot in the summer and rates are very expensive. Furthermore, they type of system described looses efficiency in cold climates.

The first week we moved into this house, I got busy with caulk, weather stripping, thermal barrier in the attic, and new attic exhaust fan just so the old system could keep up. After one winter we replaced the system, after I found the resistant heaters were on continuously. The payback for the SEER 15 system was about 10 years but like I said it either need repair or replacement.

If you want to provide some links to your Chinese junk I would be happy to review it. The key to efficiencies is heat transfer area and that cost money. Japanese design mean nothing if it does not include Japanese quality control.

Furthermore, reliability is more important than efficiency when you look at environmental impact.

The point E-P is trying to make is that it depends on several factors that the individual has to make and the government spends lots of tax dollars making poor choices most of the time.

It depends on the price of electricity but only weekly because electricity is a cheap commodity even in California. At California rates I would pay about $4 more per month.

What really matters is conservation. The difference between good insulation and poor insulation is $10 per month. The upgrades I made had a pay back period of less than a year. The upstairs rooms went from being an oven in the after noon to being comfortable even with the thermostat set higher.

My point here is that you need to do simple calculations to determine how to save money. Look at your power bill for summer, winter, and months that you do not need heating/cooling. If the cost is a $1/day per person for AC, then you SEER 26 system is going to be a very expensive way save money. Replacing an old system with a SEER 15 or 18 system should be fine.

kit P,
Prove you do "calculations" (whatever THOSE are) for "nuke" plants. Your prior posts are barely literate and hardly what a professional would write. I think you are lying and not to be taken seriously. Prove me wrong.

Since Harvey 'electricity is almost 100% clean hydro', any improvements he made did not did not reduce ghg. While my electricity is 90% coal, my conservation had benefits other than just economic.

In the USA our lights have on/off switches. Unlike Canadians, I do not need any help from government understanding the theory of operation. I do use CFL and LED lights in locations that the lights are on a longer portion of the time.

I have never had to replace a window or door because they are properly maintained. Like me. My windows are old and beautiful. Calk and paint is cheap. Never had a hot water heater that was not insulated. My wife lovers her energy efficient front loading washer because it does a great job on cleaning the cloths. Low flow shower nozzles have been code in the USA since Hector was a pup.

So far Harvey the only thing you told me is that you spent most of your life with wasteful habits but got suckers by a traveling salesman. You bought into all the expensive stuff while ignoring cost effective choices.

Replacing leaking windows and door rather than fixing then reduce energy demand 25% by my estimate.

65+Kwh/day x 75% x 30 x12 = 17,550 kwh per year is what Harvey is now using.

As I have earlier demonstrated, a SEER 15 system will provide a 50% reduction and 8875 kwh. Since says he uses 1320 kwh, he is saving 7555 kwh or 453/year.

Did not find any of those. If Harvey found some of those, his payback period would be 4 years. While I do not have enough information to find the the payback period for Harvey's system, there is nothing magic about made in China designed in Japan that would change the concepts of diminishing returns.

There are a number of problems with Gaylor and Viscusi's analysis. I have talked with several automotive leaders who firmly believe that consumers do not rationally value fuel economy. These leaders believe that (at least in the past), consumers would not pay more for better fuel economy if the true payback time was more than about 1 year. That is clearly irrational. The authors also focus on the consumer, and ignore any barriers for the industry to take risks to develop more fuel efficient vehicles. There is plenty of evidence that many automotive companies are focused on the near future, and will not do the hard work to improve fuel economy without a strong push from regulations. Every time EPA provides a new regulation to limit pollution, industry leaders claim that they can't possibly afford to meet the regulations. Then they meet the regulations for less cost than even EPA predicted. (Examples include the first introduction of the catalytic converter and the reduction of SO2 contributions to acid rain).

Gaylor and Viscusi claim that EPA and NHTSA only consider cost and fuel economy, but that is not true. I have read the proposed regulations and supporting material carefully. EPA and NHTSA consider cost effective ways to improve the fuel economy of many different kinds of vehicles, while keeping the utility of each vehicle constant. So consumers will have the same range of choices of vehicles they have now. The EPA and NHTSA analyses show that one can make cost effective improvements that will greatly reduce fuel consumption while having many other benefits including reduced greenhouse gas emissions.

One can question whether EPA and NHTSA have correctly assessed the long term cost and efficacy of improvements in technology. (The latest EPA/NHTSA estimates are optimistic compared to a 2011 study by the National Research Council). But any cost benefit study should clearly attempt to consider all the costs and benefits, as EPA and NHTSA have tried to do. Limiting the benefits to just the reduction in pollution and intentionally ignoring other benefits does not make economic sense.

So Cautious9 tell me what the costs and befits are now. Sure 40 years ago there were lots of cost effective improvements. For example all of my POVs meet emission requirements for parts of California that has air quality issues. Relaxing emission requirements for the rest of the country would achieve lower ghg emission at the same time costs of POV are reduced.

The problem is policy makers who either did not take any science course or flunked them. Each line of regulations makes saving energy more expensive. When I replaced my heat pump with one that exceeded standards, I also replaced the air handler to get the most out of the new efficient system.

My air handler is in a crawl space. I crawled in there to inspect it. The old light bulb has been replaced with and expensive CFL. I was told it was a new code requirement. Since the light bulb is almost always off it does not save much energy.

“if the true payback time was more than about 1 year. That is clearly irrational. ”

Thinking that there engineering solutions that are not very expensive is very irrational. The low hanging fruit was picked a long time ago. For 40 years I have been hearing that if we just conserve we will not have to build new power plants.

Consumers do not need regulations to make good choices to save energy but regulations will force bad choices on us.

Meanwhile, device makers will package their product with a 50¢ wall-wart power supply which wastes $1/year in energy in idling losses, and the consumer would have no choice for better options even if they jumped through all the hoops to learn how much it was going to cost them.

Thanks E-P for reminding me to to plug in my cell phone before going to work.

If E-P's point is he want government to save my a dollar a year in energy costs my making everything a lot more expensive, then I do not want help from the 'penny wise pound foolish' crowd.

If E-P had provided a calculation that showed that a regulation that changed the price of a device from 50¢ to 60¢ while saving a dollar and that there are a billion devices being sold, that might be a different story.

What is telling is E-P's agenda. What he calls waste, I call using energy to make make my life more convenient. If you want to save energy carpool or take public transportation. Leave me out of that mess. I picked a job where I can live close to work.

My point is to worry about the big stuff and keep government out of our lives unless there is an clear benefit. If you are worried about ghg, then tell your government to provide incentives to build more nukes.